The fiscal cliff should be a wake-up call?

The new year is fast approaching, and with it comes a “fiscal cliff” set to affect the economy to the tune of a combined $600 billion in tax increases and budget cuts. What is the fiscal cliff, and what has transpired in Washington such that the nation is facing it come January?

The fiscal cliff is a term created in the media and on Capitol Hill to describe what the effect on the economy might be if all of the tax legislation and spending cuts set to take effect on January 1, 2013, actually happen. Personal income taxes, dividend and capital gains taxes, estate tax exemptions and payroll taxes will all be affected. Forbes reports the GDP could decrease by as much as 4.5 percent.

We are facing “the cliff” as of this moment. If Congress does nothing through the end of the year and allows the Bush tax cuts to expire, many Americans will experience increased taxes.

This should be a huge wake-up call to all people out there saving for their retirement. From a retirement-planning perspective, what you have been doing for the past few decades may not make fiscal sense in the present. Many Americans still hold firm to the belief that the best retirement saving strategy is to invest on a pre-tax basis, and pay taxes in the future when the money is forced out.

But if taxes increase in the future (as they are currently set to do), you’ll end up paying more when you pull out your funds than if you had invested after-tax dollars today and allowed them to accumulate tax-free instead.

As I counsel my clients every week, I find that many are not aware of how our tax brackets have changed over the years, and what it means to them and their retirement.

Consider a family with a household income of $50,000. This income places them in the 15 percent tax bracket ($17,000-$70,000 of taxable income). If the current tax structure were to remain the same throughout their lives, these individuals will probably never be in a lower tax bracket, so the main reason to invest pre-tax will not occur.

But what happens if taxes go up? Since no taxes were paid on the money used to fund 401(k)s and IRAs, they will be taxed upon disbursement – and at the higher rate than those we are experiencing today.

If you believe that taxes will go up in the future (remember the fiscal cliff?), then it could make the most sense to invest post-tax dollars today (like in a Roth) as opposed to investing pre-tax dollars (like a 401(k) or traditional IRA) today and take the tax hit in the future.

Why gamble on an unknown future with an unknown tax rate, when you know the facts today? We are in a fiscal crisis, the debt has ballooned to $16 trillion and the costs of our entitlement programs are looming on the horizon.

If you haven’t considered different approaches to retirement saving, you might benefit from meeting with a financial advisor to talk about your individual situation. Make sure your plan of action is what’s best for your long-term retirement success, not just your short-term savings.

Joe Wirbick is the president of the Lancaster, PA financial services firm Sequinox. Joe specializes in retirement planning and distribution. This allows him to concentrate on developing strategies that help address the unique issues that confront retirees and those approaching retirement.

Tax advice provided for informational purposes only. Tax returns should be completed in conjunction with a qualified tax professional. Sequinox Financial and JWC/JWCA do not offer tax advice and are not affiliated. Mr. Wirbick is an Investment Advisor Representative offering advisory services through J.W. Cole Financial Advisors, Inc.. (JWCA) and securities through J.W. Cole Financial, Inc. (JWC) Member FINRA/SIPC. The opinions expressed are those of Mr. Wirbick and based on information believed to be reliable but not guaranteed and subject to change and do not necessarily reflect the position of JWC/JWCA.JWC/JWCA and Sequinox are unaffiliated independent entities.